Mile High Inc. was formed in March 2011 to provide prepackaged snack boxes for a new low cost regional airline beginning April 1. The Company has just leased warehouse space central to the two airports to store materials.
To move packaged materials from the warehouses to the airports, where final assembly will take place, Mile High must choose whether to lease a delivery truck or pay a full-time driver at a fixed cost of $5,000 per month or pay a delivery service a rate equivalent to $0.40 per box. This cost will be included in either fixed manufacturing overhead or variable manufacturing overhead, depending on which option is chosen. The company is hoping for rapid growth, as sales forecasts for the new airline are promising. However, it is essential that Mile High managers carefully control costs in order to be compliant with their sales product and remain profitable.
Ron Spencer, the company's president, is trying to determine whether to use absorption or variable costing to evaluate performance of company managers. For absorption costing, he intends to use the practical capacity level of the facility, which is 20,000 boxes per month. Production volume variances will be written off to cost of goods sold.
Costs for the three months are expected to remain unchanged. The costs and revenues for April, May and June are expected to be as follows:
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Sales revenue
|
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$6.00 per box
|
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Direct material cost
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$1.20 per box
|
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Direct manufacturing labor cost
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$0.35 per box
|
|
Variable manufacturing overhead cost
|
|
$0.15 per box
|
|
Variable delivery cost (if this option is chosen)
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$0.40 per box
|
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Fixed delivery cost (if this option is chosen)
|
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$5,000 per month
|
|
Fixed manufacturing overhead costs
|
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$15,000 per month
|
|
Fixed administrative costs
|
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$28,000 per month
|
Projected production and sales for each month follow. High production in May is the result of an anticipated surge in June employee vacations.
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Sales (in units)
|
Production
|
|
March
|
0
|
12,200
|
|
April
|
12,000
|
18,000
|
|
May
|
12,500
|
9,000
|
|
June
|
13,000
|
12,000
|
|
Total
|
37,500
|
39,200
|
Since Mile High is a start-up business, they were able to negotiate extended payment terms with direct materials vendor. Their standard payment terms of 30 days were extended to 60 days for the first three months. Payments for variable manufacturing, fixed manufacturing and administrative costs are payable in 30 days. Labor costs are payable in the month incurred. Regional airports are billed upon delivery and have 30 day payment terms with the opportunity to qualify for a 1% discount by December 31 based on timely payment experience. Mile High anticipates that 50% of their customers will pay within the first 30 days and 20% will pay within 60 days. The remaining 30% will take 90 days to remit payment. This experience data is based on benchmarking of industry trends. Ideally the 1% discount will serve as an incentive for customers to pay faster than the benchmarking data suggests.
Ron Spencer is the sole proprietor of Mile High and he contributed $82,000 of packaging equipment to the business in exchange for his ownership. He was able to secure a line of credit $75,000 from a business associate which will be drawn down March 2013 to fund the initial operating expenses of Mile High. He will be successful in attracting additional investors if Mile High reaches its sales targets and can effectively manage cash flows during this critical startup period.
In an effort to further manage costs, Ron Spencer has hired his nephew Arnold, an undergraduate accounting student, to assist with preparing the projected income statement, balance sheet and cash flows.
1. Prepare a budgeted income statement, under absorption costing for Mile-High for the months of April, May and June assuming that Mile High opts to use the variable delivery service. Include supporting schedules to support the revenues and manufacturing costs.
2. Prepare a cash budget (budgeted statement of cash flows) for the months of April, May and June. Include supporting schedules for customer collections and vendor payments.
3. Prepare a forecasted balance sheet for the months of April, May and June using budgeted income statements and the budgeted statement of cash flows.
4. Will Ron Spencer achieve his goal of attracting additional investors based on the budgeted operating results and financial position for the months of April, May and June for Mile High? Why or Why Not?
5. Are there any operational trends that you would bring to the attention of Ron Spencer? What operational changes if any should he consider to address these trends?